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Intermediate Microeconomics Final [150 points]
Clearly label all graphs for full credit and please write legibly; I cannot grade what I cannot read. Show your work for full credits. The number of points each question is worth in parentheses.
1. (20) Last year, the price of heating oil was $4 per gallon, and Jennifer purchased 100 gallons of heating oil. This year, the price of heating oil falls to $3 per gallon while Jennifer's income is unchanged. Jennifer decides to share her good fortune by giving her retired father a gift of $100. Consider an indifference curve-budget line diagram with heating oil on the horizontal axis and "all other goods" on the vertical axis. (i) (4) Does the price change make Jennifer's budget line flatter or steeper? Justify
(ii) (6) After Jennifer gives the $100 gift, will her new budget line lie above, lie below, or pass through her initial optimum? Justify your choice.
(iii) (10) Sketch an indifference curve-budget line diagram that illustrates this situation. This year, will Jennifer be better or worse off than she was last year?
2. (20) The manager of a firm receives an engineering report claiming that an additional hour of capital would add twice as much output as would an additional hour of labor. According to the firm's accountants, an hour of capital costs 3 times more than an hour of labor. (i) (6) Is the firm on its expansion path? Why or why not?
(ii) (6) Suppose the firm is under contractual obligations to keep its output at current levels. What long-run adjustment (if any) should the manager make in the firm's employment of labor and capital?
(iii) (8) Sketch an isoquant-isocost diagram that illustrates the situation described in part ii. Label the initial situation "A" and the post-adjustment situation "B." The scale of your diagram does not need to be accurate.
3. (30) Suppose donuts are produced by a competitive constant-cost industry, which is initially in a long-run equilibrium. For each of the following situations, design a supply-demand diagram that shows how market price and quantity will be affected in both the short run and the long run. In your diagrams, show the short-run supply, long-run supply, and demand curves, along with any shifts in these curves. Label the initial long-run equilibrium E0, the new short-run equilibrium E1, and the new long-run equilibrium E2. (i) Donuts decline in popularity as more and more people choose to consume
healthier breakfast. How are the profits of donut firms affected in the short run? How are their profits affected in the long run?
(ii) New health regulations require each donut firm to make a onetime donation to the
OAC (Obesity Action Coalition). Who pays for this increased cost in the short run? Who pays in the long run?
(iii) The cost of flour falls, which reduces the cost of producing each donut by 50 cents. Who pays for this decreased cost in the short run? Who pays in the long run?
4. (30) A firm faces the following demand for its output: P = 200 - 0.5Q. The firm’s cost structure is defined by the following Total Cost function: TC = 100 + 20Q + .5Q2 i. (10) Please find the firm’s profit maximizing level of output and profit.
ii. (8) Graph the situation and indicate on the graph any Deadweight Loss resulting from the monopoly.
iii. (6) Calculate the Deadweight Loss and explain why it is the Deadweight Loss.
iv. (6) What is the socially efficient quantity?
5. (20) The inverse demand curves that Sony, the monopoly manufacturer of robot dog, faces in the two countries, the United States and Japan, are PJ = 3500-0.5QJ & PUS =4500-QUS. Sony’s marginal cost is given by MC = 500.
i. (5) In general, what are the conditions needed for Sony to be able to do the
3rd degree price discrimination?
ii. (8) What is Sony’s profit maximizing quantity and price in each country when Sony has the conditions for 3rd degree price discrimination?
iii. (7) If Sony is forced to charge a single price, what is the profit maximizing quantity and price?
6 (10) Explain why a profit-maximizing monopolist will always sell at a price where demand is
7. (20) Two identical firms face a market demand curve of P = 50– 0.5Q. Their marginal cost of production is a constant $8. (i) Suppose the two firms form a successful cartel. How much will the firms produce, and
what price will they charge?
(ii) Suppose the firms behave as in the Bertrand model of oligopoly. How much will the firms produce, and what price will they charge?
(iii) Suppose the firms behave as in the Cournot model of oligopoly. How much will the firms produce, and what price will they charge?
8. (Bonus) Suppose that there are two home improvement retail stores, the Home Depot and Lowe’s. Let us assume there are 6 consumers trying to buy a lawn mower. Consumers will shop around and buy from a store which offers a lower price than the other. If two stores offer the same price, two stores will split the market. (each store will get 3 consumers.)
a. What are three elements of the game? Does this game have all three elements?
b. Construct the payoff matrix and find a Nash equilibrium if there are any. (Home Depot, Lowe’s) Total Revenue
Low Price ($150)
High Price ($200)
Suppose both stores have ‘110% money back guarantee pricing policy’. If a consumer finds a better deal anywhere else, the stores not only match the price but also give a further price cut by 10% of the difference.
c. Construct the payoff matrix and find a Nash equilibrium if there are any. (Home Depot, Lowe’s) Total Revenue
Low Price ($150)
High Price ($200)
d. Is this policy good for consumers? Support your answer.